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6 Strategies to Help Lower RMD Taxes
Applying some smart strategies could potentially help reduce your RMD taxes.
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IN THE PRESS:
Individual Retirement Accounts (IRAs), 401(k)s and other workplace plans can help you build wealth for the future while enjoying some tax benefits.
There's just one important thing you need to plan for: required minimum distributions (RMDs). The IRS requires you to begin taking distributions from certain retirement accounts in the year you turn 73.
If not properly planned for, these distributions could take a potential tax toll on your retirement nest egg. Applying some smart RMD strategies could help reduce distributions and potentially lower your tax bill.
Consulting a fiduciary financial advisor can be a great first step to factoring RMDs, and the potential tax repercussions, into your retirement plan.
Research suggests people who work with a financial advisor feel more at ease about their finances and could end up with about 15% more money to spend in retirement.1
A 2023 Northwestern Mutual study found that 66% of U.S. adults admit their financial planning needs improvement. However, only 37% of Americans work with a financial advisor.2
Net worth from age 45 to 77
Final lifetime net worth with and without a financial advisor.
Disclaimer: This example demonstrates the potential final lifetime portfolio value, accounting for estimated investment returns, tax savings and inflation over different life stages for an individual starting with $500,000 at age 45, through age 77. Under a set of core assumptions, this consumer profile is projected to have a final lifetime portfolio value of approximately $3.24 million if retaining the services of a financial advisor – not accounting for additional savings or portfolio withdrawals – versus a final estimated lifetime portfolio value of $1.56 million without the services of a financial advisor. This example is based on the valuation framework presented in SmartAsset's whitepaper “The Value of a Financial Advisor: What's It Really Worth?” (Nov. 2024). The value of professional financial advice is only an illustrative estimate and varies with each unique client's individual circumstances and portfolio composition. Carefully consider your investment objectives, risk factors, and perform your own due diligence before choosing a financial advisor.
Disclaimer: This example demonstrates the potential final lifetime portfolio value, accounting for estimated investment returns, tax savings and inflation over different life stages for an individual starting with $500,000 at age 45, through age 77. Under a set of core assumptions, this consumer profile is projected to have a final lifetime portfolio value of approximately $3.24 million if retaining the services of a financial advisor – not accounting for additional savings or portfolio withdrawals – versus a final estimated lifetime portfolio value of $1.56 million without the services of a financial advisor. This example is based on the valuation framework presented in SmartAsset's whitepaper “The Value of a Financial Advisor: What's It Really Worth?” (Nov. 2024). The value of professional financial advice is only an illustrative estimate and varies with each unique client's individual circumstances and portfolio composition. Carefully consider your investment objectives, risk factors, and perform your own due diligence before choosing a financial advisor.
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What Are RMDs?
RMDs are amounts you're obligated to withdraw from certain tax-advantaged retirement plans, including:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans
- 403(b) plans
- 457(b) plans
- Profit-sharing plans
- Other defined contribution plans
Roth IRAs don't have RMDs, so you can leave money in those accounts as long as you live. While Roth IRAs do not have RMDs for the original account holder, beneficiaries who inherit a Roth account may be subject to RMDs.
When Do RMDs Kick In?
Currently, RMDs begin at age 73. There is some flexibility for your first payment, which technically isn’t due until April 1st of the following year. However, you’ll still owe your second RMD by the end of your second year even if you wait to make your first payment.
The amount you're required to withdraw is based on your account balance and life expectancy (according to IRS tables). Withdrawals are taxed at your ordinary income tax rate. Failing to take RMDs on schedule can result in a 50% tax penalty.
6 Strategies to Reduce RMD Taxes
Taking RMDs can potentially be problematic from a tax perspective. If you have large balances in your IRAs or workplace retirement accounts, taking RMDs could inflate your tax bill.
Here are six common ways to potentially shrink your RMDs in order to minimize taxes:
1. Draw Down Your Account Early
Once you turn 59 ½, you can begin taking money from retirement accounts without a tax penalty. Taking larger distributions in the early years of your retirement can reduce your overall account balance, lowering your RMDs later. This option could make sense if you expect to be in a lower tax bracket when you retire.
Drawing down your retirement accounts before age 73 can offer another benefit. You may be able to delay taking Social Security benefits. The longer you delay benefits beyond your full retirement age, the more your benefit amount increases. If you can wait until age 70, for example, you'll receive 132% of your benefit amount.
2. Consider a Roth IRA Conversion
Roth IRAs offer the benefit of 100% tax-free qualified withdrawals – and they don't have RMDs. If you'd like to avoid RMDs, you could convert your traditional retirement funds to a Roth account. You'll have to pay tax on the conversion in the year it occurs. But it may be worth it to take a one-time tax bill hit in order to avoid RMDs and withdraw remaining retirement funds tax-free.
While converting traditional retirement funds to a Roth account may be an option to consider for avoiding RMDs, it is not guaranteed to be worth it for everyone. Tax implications should be carefully considered and consulted with a tax professional. A financial advisor could help determine if this could be a viable strategy for you. This free quiz can match you with vetted fiduciary financial advisors who serve your area.
3. Work Longer
If you have some of your retirement funds in your current employer's 401(k), you might consider working longer to avoid RMDs. As long as you're still working in some capacity, you're not required to take minimum distributions from a workplace plan where you're still employed.
That exception doesn't apply to retirement accounts you had with previous employers. You won't get a pass on IRA RMDs either. But continuing to work could help to reduce the total amount of RMDs you need to take once you turn 73. And again, you can delay Social Security benefits as well.
4. Donate to Charity
One of the most popular RMD strategies for reducing taxes involves donating the amount to charity. The IRS allows you to donate up to $100,000 a year from an IRA without having to pay income tax. The money you withdraw will still count toward your RMD so you don't have to worry about a 50% tax penalty for failing to take distributions.
There are a few rules for this strategy:
- You can only donate up to $100,000 to a qualified charity
- Your IRA custodian must arrange for the transfer of funds to an eligible charity
- You're not allowed to claim the donation as a charitable deduction your taxes
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5. Consider a Qualified Longevity Annuity Contract
A qualified longevity annuity contract (QLAC) is a type of deferred annuity contract. You can use your retirement funds to purchase the annuity, then receive payments back at a later date. Payments are required beginning at age 85 and any money you put into the annuity does not factor into your RMD calculations.
However, you can only put so much money into a QLAC - up to $200,000. While you can defer taking payments until age 85, you can't avoid them indefinitely.
6. Check Your Beneficiaries
If you're at least 10 years older than your spouse and name them as the sole beneficiary of your retirement account, you can use the IRS Joint Life and Last Survivor Expectancy Table to calculate RMDs.
This strategy allows you to use your spouse's longer life expectancy to determine how much to withdraw, which can lower the amount. Of course, if your spouse is closer to your own age or you have multiple beneficiaries, you wouldn't be able to use this RMD strategy.
Where to Look for RMD Advice
Applying RMD strategies can be a simple way to reduce what you owe in taxes during retirement. You can use just one strategy or apply several in order to bring down your tax bill. While these strategies can help reduce RMDs, there's no way to avoid RMDs indefinitely (unless you have a Roth IRA).
Consulting a fiduciary financial advisor could help you determine a plan that factors RMD taxes into your overall retirement goals. Fiduciaries are obligated by law to act in your best interest as they manage your assets or money, and any potential conflicts of interest must be disclosed.
Yet knowing how to find a vetted fiduciary advisor is, for many, the most confusing task of all. Common Google searches related to the topic reveal a desperate search for direction. “Fiduciary financial advisors near me,” “best fiduciary financial advisor,” and “financial investment advisors near me” are searched for hundreds of times per day.
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